Research

In an Harvard Business Review post Rob Wheeler makes the case for the Kindle Fire as a disruptive innovation. I believe that it is but crucially I disagree that the Kindle Fire is a low end disruption.

My assessment of the Kindle Fire is based on the two attributes which Amazon highlights as the key selling points which offer a basis of differentiation and potential for asymmetric competition: a low price and a new browsing model. I believe that these two attributes result in two opportunities: one for low end disruption and another of new market disruption. I reject the first and tentatively support the second.[1]

The price

It's immediately obvious that the price point of the Kindle Fire is well below alternatives. That forms the basis of disruptive potential, but before we jump to analyzing the disruption hypothesis we should determine whether and to what extent Amazon profits from the device directly. Profitability gives us a clue to where Amazon will apply resources and thus establish its trajectory of improvement.

We know the margin on the Fire is low because we can calculate the bill of materials for 7" tablets. Gene Munster of Piper Jaffray estimates that Amazon "loses" $50 for each unit sold. We also know that the design Amazon used is essentially very similar to the RIM PlayBook and was sourced from the same ODM. RIM priced the product at $499 but has struggled to find buyers and is reluctantly dropping the price. We also can estimate that Apple with a product having more than twice the screen size is keeping modest (~30%) gross margins for at a price point approximately double that of the Fire. It does seem that Amazon does not have much or any margin to dip into.[2]

So the Fire can be classified as a low price product. Does that make it a low end disruption?

Disruption requires asymmetry but it also requires the ability to go up a trajectory of improvement along the basis of performance that a majority of users demand. The first condition is met, but what of the second? In a combined system where one asset is used to leverage another--the subsidized being sacrificed to benefit the profitable--success is conditional on one element being "good enough" while the other "needing improvement". Investment follows accordingly.

But investment decisions have consequences. The subsidized device is starved of investment while the profitable service is nurtured. We see evidence of short cuts in investment in the off-the-shelf nature of Kindle products: from a second-hand (unsanctioned) OS to a second-hand (ex-RIM) hardware. Meanwhile, Amazon spends heavily on capex for the infrastructure that delivers the profitable content.

If the hardware is indeed commoditized and cannot be usefully improved, then this model works. If, on the other hand, the hardware and systems software can benefit from dramatic improvements in technology then the model fails. The very asymmetry of a service vs. a product turns into the latter having all the advantages and the former failing to gain traction.

I'll give three examples of this how service model creates limitations which lead to a failure to disrupt a product model.

The Game Consoles

The first is the game console business. In consoles, the vendors maintain long hardware product life-cycles to recover their hardware investment and subsidy by maximizing the number of games attached to each console. If you plot product cycles you realize that the bigger the subsidy, the longer the hardware lifecycle. The result is a very wide turning circle which prevents innovation in new dimensions.

Consider that the Playstation or the Xbox could have been a low end computing disruption. The original Xbox was in fact a PC. It was supposed to bring PC dynamism to the console business and create a cottage industry of new developers building games on commoditized hardware. However by the second generation the Xbox was a locked down, custom architecture, pure gaming machine. Gone was Intel, gone was the PC architecture and gone was any dream of cheap development.

This is entirely due to the economics of subsidized hardware. It compelled Microsoft, the world's greatest software company, built on the open and cheap PC architecture to make closed, expensive hardware. Sony followed in kind as did Nintendo. Each generation of consoles was a sustaining improvement on gaming and had no ambition beyond gaming[3]. The subsidy and the dependence on an integrated content value network led to a distinct lack of disruption and an insular industry which continues to seek out increasingly immersive experiences for increasingly demanding customers while itself being disrupted by casual, mobile gaming.

The Set-top boxes

The second example is the TV set-top box business. There again, the vendors maintain long hardware cycles in order to recover subsides. There too, the main value driver is the content and its distribution which stipulates the architecture, and through subsidy, defines its evolution. This offers the vendor no motivation to improve the user experience[4], secondary uses or the absorption of new streams of content (like those the internet can offer.)

Again, the set-top box could have been a budding disruptive opportunity for Microsoft. They invested billions in the 1990s to acquire placement of software on set-top boxes in an attempt to penetrate the living room. And again Microsoft was not alone. Since then Tivo, Google and Apple and many others tried to attach cheap hardware to video streams. They all failed to get on a disruptive trajectory. And again, the blame can be placed on the stifling effect of subsidies and dependencies on services or content which dictate where the value and hence the investments should go.

The Blackberry

The third example is the RIM Blackberry. Although RIM made most of its money on hardware and was by no means subsidizing it, the differentiation of their product was undoubtedly its service value. Both as a corporate device with BES and as a consumer device with BBS, customers "hired" the product as a service. By being committed to this model RIM management became blind to the hardware and client OS software innovations coming down the pike.

Through their own admission, they could not accept a touch screen because it would make the messaging experience too slow and it is messaging that sells Blackberries. They could not accept apps (and hence platform orchestration) as a differentiation because their customers did not hire Blackberries for "lifestyle apps". Merely being differentiated as a service leads to blindness and enough hesitation that you run off the disruptive rails.

People ascribe myopia or incredible absence of mind to RIM's management but the opposite is true. They were deeply committed and observant of the things which made the Blackberry successful. It just happened to be something that stopped being relevant.

The iPhone

I'll add one more "bonus" example on this. The iPhone is also a subsidized product and it seems very successful. How come it won? The answer is in details. As I mentioned, the other products ended up in poor life cycles or incorrect motivations. The iPhone differs in that the lifecycle of the product is much shorter (2 years ownership with 1 year for product updates). The shorter lifecycle works for the iPhone because it has a very high service revenue base to dip into to offset the subsidy. Something none of the content models above could count on.

Consider that each game console subsidy needs to paid off by a handful of game titles whose royalties to the console maker are modest. Or that the TV box needs to ride on top a service that also has thin margins from a stable or slightly shrinking user base. In contrast, the iPhone enables vast new consumption worth thousands of dollars to the operator. This is the famous ARPU uplift that smart phones enable. Users are doubling their telecom spending when they move to smartphones.

The margins for Kindle content are thin. Very thin. Apple runs its content business at break even though it transacts billions of items per month. The amount of content that needs to pass through the Kindle ecosystem (with lower prices than Apple charges) will need to be astronomical to make it profitable on the shortened cycle time the iPhone enjoys. Thus the Kindle is likely to languish in a leisurely update cycle with users encouraged to hang on to their devices for years. This is the case at least with the original e-Ink Kindles. How eagerly awaited are new generations? How many users stampede to update the hardware or even upgrade the software? How many users have owned every version of the Kindle?

Service Scale

Finally one last point about services. As Amazon asserts, they see Kindle as a service, which, I concede, is asymmetric to a product business. The problem is that services don't scale as well as products. Consider that none of the content streams that Amazon will depend on are available outside the US. The Kindle has not been a strong seller internationally. This is because book rights are limited to national boundaries as are movie rights and song rights. Apple has only this week finally completed the rollout of iTunes music to all of Europe! A process that took almost a decade. And they are still unable to sell music in most of Asia and forget about movies or TV shows.[5]

The reality is that there are no global service brands. Not in telecommunications (operators are, at best, regional), not in Media (TV, radio, publishing are a local businesses), not in Banking (not even in commercial banking) and not in Retail (even Wal-Mart was humbled trying to export its disruption). The internet has not broken down any of these boundaries and even Amazon has modest reach outside the US for any of their franchises. Services are local but products can be global.[6]

To wrap up, this discussion on the asymmetry of device-based services to product models leads me to conclude that the Fire will not have the opportunity to disrupt the iPad or tablets in general. Amazon sees the hardware and software of a device as a commodity and the content and its distribution as valuable. This assumes that the device is "good enough" and will not require deep re-architecting or that new input methods can be easily absorbed. In short, they see the tablet as at the end of its evolutionary path. Apple sees the exact opposite. The iPad is 18 months old, and as they say in the ads, they see it as only the beginning.

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Notes:

1. Due to length of discussion, in this post I will make the case against the low end disruptive potential and use a second post to make the case for it being a new market disruption.
2. Presumably, Amazon will also distribute only through Amazon.com and thus not incur channel mark-ups. This means that comparisons with other tablets should be at a price nearer to 70% of retail.
3. Gaming networks and video streaming are extensions but neither leveraged open architectures.
4. See also discussion from June 2010 on the challenges to Apple TV that Steve Jobs enumerated.
5. Apps are another story. Because it controls the medium, Apple can and does sell apps in every country where the iPhone or iPad or iPod touch is available.
6. Note also that because of distribution through Amazon.com, the Kindle cannot reach as many buyers as a tablet selling through the tens of thousands of points of purchase that operators and retail shops offer.

 

I've been providing analysis of Apple's operating and financial performance for some time. Recently we've begun to look at comparisons of financial performance for comparable companies. Now it's time to dig deeper and do comparisons of operating performance as well.

To start, Microsoft.

Whereas Apple has product lines (iPhone, iPad, iPod, Mac, iTunes, Peripherals and Software), Microsoft has business divisions (Windows & Windows Live, Server and Tools, Online Services, Business (Office), Entertainment and Devices). The charts show revenues for both Apple and Microsoft according to these defined segments.

 

The second chart should be a familiar one:

Note that the horizontal and vertical axes are the same. The period of coverage is from mid-2007 to the end of June 2011 which corresponds to the life of the iPhone. The vertical axis ranges up to $30 billion/quarter in both charts.

When shown this way, the exceptional growth for Apple becomes easier to understand (and perhaps Apple's valuation premium of 15.7 P/E vs. Microsoft's 9.5). Microsoft has been growing these past four years but not nearly at the rate of Apple. Microsoft grew quarterly revenues from the ~$15b range to ~$17b range.

Additional points of interest:

• The Mac business generates more Revenue than Windows
• iOS powered devices generate more revenue than all of Microsoft's products put together
• Apple's revenues grew 413% since Q2 2007 while Microsoft's grew 26%
• The release of Windows 7 had a marked effect on revenues in the launch quarter but the sales did not seem to grow above the previous version's run rate ($4.2b/quarter vs. $4.7b/q on average).

But most importantly, whereas Apple's growth has come from new businesses (iPhone and iPad), Microsoft has organically grown existing businesses. The condemnation of leadership at Microsoft should hinge on the absence of significant top line growth. Note that neither the Online Services nor the Entertainment and Devices divisions had appreciable net growth.

 

On October 4th, Tim Cook will take the stage at Apple’s fall event. With Steve Jobs’ transition to head the Board of Directors of Apple and after serving as CEO for fourteen years, it is time to take a look at his reign.

Looking at his performance vs. peer companies from a capital market performance, I have composed the following two charts:

Market capitalization of selected peer companies by calendar quarter in USD million sorted by most recent market capitalization (1997-2011)

Market capitalization as share of combined market capitalization by calendar quarter sorted by most recent market capitalization (1997-2011)

You will note that I included more companies than in previous analysis. The new additions are:

• Compaq (acquired by HP in 2002)
• Palm (acquired by HP in 2010)
• Amazon (a popular request by readers)

I divided this era into three distinct periods:

Restructuring of Apple 1997-2000

In the beginning of 1997, Apple’s market capitalization was lower than almost all of its peers. In absolute terms the market capitalization moved only slightly upwards towards 1999 and the dent in 2000 is significantly lower compared to the market capitalization increase of other companies, first and foremost Microsoft's. Especially in the early part of this period restructuring and streamlining efforts took precedence. The introduction of iMac in 1998 and the iBook in 1999 set the tone in terms of design, quality and "thinking different" for many years to come.

iTunes era 2001-2006

With a stable core business and healthy profitability, Apple introduced the first iPod in October 2001 complementing the earlier introduced iTunes music player. Two years later, Apple introduced the iTunes Store offering downloadable music for the Mac and Windows operating systems. The venturing into the music and portable music player business and the halo effect for the Mac business is reflected in the market capitalization increasing significantly during the following years surpassing HP and Nokia.

Mobile iOS devices 2007-2011

Market capitalization further increased with the entry into the smart-phone market in 2007. Note that market capitalization of all selected companies combined at that time was as high as in the dot.com era of 2000. But this time Apple accounted for more than 10% of it. From 2008 to 2009 market capitalization of all companies declined severely due to the financial crisis. Rapid recovery followed during 2009 and early 2010. Apple introduced the iPad in March 2010 further fueling its rise to the top, surpassing Microsoft’s capitalization and topping Exxon Mobil as the world's most valuable listed company.

During the time of Steve Jobs as CEO, Apple's market capitalization increased on average by 42% every year--an unprecedented track record. According to his own admission, Steve Jobs became CEO when Apple was 90 days away from bankruptcy. He resigned 14 years later after leading Apple to becoming the most valuable listed company in the world. From a value creation point of view, it's hard to think of a better performance from anyone, ever.

Apple's share price has recently hit a new all-time high, over $400 per share. As often happens there was no specific new information from the company to justify this increase. On the other hand there is usually no news to justify share price drops in Apple. In fact, the stock is up on what would be considered counter-indicative news: the resignation of a very important CEO.

But readers may recall that there is a measure of performance for Apple we can turn to that seems to show strong correlation to its stock price. It's not income and it's not growth in income but it's the strength of the balance sheet.

I demonstrated this relationship last May with a post titled The market values Apple’s balance sheet, not its income statement.

It's time to look at the data again to see if the relationship still holds. I added the data for Q2 and made some estimate about the cash position since July 25th (we will know this data with more accuracy when Q3 data is reported in a few weeks).

The slope of the line above has decreased slightly but a strong correlation can still be observed. The old r-squared was 0.94 and it is now 0.90. I included the formula for the y variable (share price) as a function of x (cash).

If you plug in $100 for x you get about $500 for y. So if this relationship continues[1], the answer to the question in the title would be "When the cash and cash equivalents reach $100 billion."

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Note:

1. Note that whether the relationship holds (which it very well may not) depends on a strong correlation and "strong" is not well defined. The correlation has weakened slightly in the last six months.

Announcing a new HBS PRESS BOOK

Decoding Steve Jobs: Select Commentary from HBR.org

by Norm Smallwood, Kate Sweetman, Dave Ulrich, Rosabeth Moss Kanter, Jeffrey Pfeffer, Horace Dediu, James Allworth, Max Wessel, Rob Wheeler, Bill Taylor

Source: Harvard Business Press Books

14 pages.  Publication date: Sep 22, 2011. Prod. #: 10973-PDF-ENG

"The news of Steve Jobs's retirement from Apple may be losing steam but observations on his legacy - and Apple's leadership future - are only beginning. In recent years, leading thinkers have contributed their thoughts on the Jobs phenomenon on HBR.org. We've compiled a few of the best here, and we invite you to read them through the lens of business lessons to be learned.' We've selected six pieces: two from after Jobs's August 2011 announcement and four from before. We hope you will enjoy them, learn from them, and continue to turn to HBR.org for ideas and inspiration.

Available for download for $1.99 via Decoding Steve Jobs: Select Commentary from HBR.org - Harvard Business Review.

[Updated with new charts including data from StatCounter and not NetMarketshare]

Generally speaking there is an equivalence drawn between iOS and Android as technologies and even as user experiences. However, as I've pointed out on several occasions there is a very clear nonequivalence in business models and thus the "fuel" which keeps each platform running. But does this difference in models lead to some difference in the way the products are "hired" to do what they do. Does it imply anything about how the products are likely to evolve?

I collected into one place all the data I could find about utilization (how much of a service and how often it's used) and possession (both in terms of current ownership and new acquisitions) of iOS and Android.

Possession data comes from comScore survey data of share of US installed base of smartphones by platform at the end of June 2011 (first chart) and share of Global Smartphone Purchases as of Q2 2011 sourced from company reports and IDC (second chart).

Utilization data (vertical axes) comes from August  2011 shares of mobile browsers (from StatCounter June 2011), in-airport WiFi associations from Boingo in June 2011 (iPhone vs. Android), in-flight Wifi associations from Gogo in June 2011,  and In-app Ad impressions from Millenial Media also in June.

The charts are divided into nine sections corresponding roughly to "low", "medium" and "high" utilization vs. possession.

The first chart compares a US-only population for possession vs. a mixture of global and US-only populations for utilization. The second chart compares a global population to the mix of US and global metrics.

What I found interesting is that if we take ad impressions (red X) and browsing (blue +) data out, the two platforms are indeed quite distinct. iPhone has a medium level of possession with a high level of utilization of data services while Android has a high level of possession with a low level of utilization. The data is also nicely clustered.

If we take just the ad impression or browser data then the platforms are quite similar: medium utilization for medium possession and high utilization for high possession. If the two platforms were to swap places in possession (i.e. market share) then they would probably also swap places in utilization (i.e. impressions).

What the data seems to suggest therefore is that for data services the iPhone is a far more popular tool than Android. But for in-app ad impressions and browsing the products are used in a similar manner.

The big difference is however that the services where iPhone utilization is high are those where users have to pay something. Most (if not all) of the ad impressions in apps are for free apps. So ad consumption scales with possession. But non-free services don't. This data seems to support the hypothesis that Android users are disproportionately less willing to spend money (note that the data does not say that users don't have money, but simply that they are not spending it). The other data which backs this hypothesis is that paid app sales on Android trail quite far behind the rate of purchase on iPhone. That could be due to payment problems in the Android marketplace but this data shows that there is some other effect as well.

Why is this important?

We can argue that Android is a low end product and that it disrupts and that this is consistent with that positioning. However it also indicates that the value is not in that ecosystem. And ecosystems are what sustain a platform in the long term. This debate will continue but I am reminded of other platforms which had similar patterns.

Both the Blackberry and Symbian had high possession (in terms of share) with very low utilization. There were lots of surveys which showed that browsing, app downloads and "monetization" of services after the sale of the handset were low. Much was written about it being due to poor experiences. But learned observers today insist that the experience on Android is as good as on the iPhone.

So why is there less economic participation from Android users? It's not just about these proxy services, but all manner of activities which enrich an ecosystem. Possession without utilization implies a product that does not do its job. Its features are not being absorbed. Why would that be?

 

In the post on OS turning circles, I used the concept of a radius of turning as an analogy for agility. One problem with the analogy is that turning in circles implies a return to a starting point or at least a closing of the loop. The idea is that there is lifecycle repetition. However, in reality, this does not apply to the world of operating systems.

An OS, as a platform, usually has a finite life. It is born, grows and usually reaches a point where it is no longer supported. Sometimes, a new platform is born to take its place from the original owner but more often a replacement comes from a new challenger company.

So rather than circles, the analogy of OS lifetimes may be more accurate.

If we do think of platforms as finite, then the natural question is what causes an end? We need to look for patterns which may indicate when a platform is reaching end of life.

The difference in this analysis is that the measure of "age" of a platform I use is not time per se but versioning. The logic is that each major version is a meaningful and significant improvement in a platform which needs to be delineated, marketed and celebrated. It embodies the business logic as well as the engineering logic of the platform custodian.

Taking the data from the last post I added a few more platforms: Symbian[1], PalmOS and Blackberry OS[2] to seek out patterns. I also separated the desktop/portable OS's from Mobile OS's and plotted these version-demarcated lifespans.

One thing to observe is that the scales of the two charts are comparable. There are examples of short- and long-term version updates and the number of iterations (lifespan) can be similar. I noted also that there were several platforms which have reached end-of-life[3][4]. Those platforms have a big black dot at the end of the line.

That leads to another observation. The end of a platform seems to be indicated not by simple age (the shortest lived was six years and the longest lived was 16) nor by the number of versions (PalmOS lived for five while MacOS lived for nine). Instead the end of life is most clearly visible as a lengthening of the development cycle.

Note that each platform that ended was preceded by a spike into the vertical--a significant delay in the release of a version. The data is one thing, but it's anecdotally supported by observation. Industry observers note that delays in improving the product are symptoms of some fundamental architectural or marketing roadblock. In the case of Mac OS, Apple struggled to bring modernity to its "Classic" OS. It need memory management, more reliability and a better file system to support the move to networking and media hub use that defined the consumer expectations of a PC.

There was a change in the basis of competition, away from pure productivity and more toward entertainment that turned out to be more demanding in new ways. Apple had to move away from Mac OS and lost time with its internal Copland effort before punting with NextSTEP. Similar transitions are visible with Palm (from PalmOS to WebOS), Microsoft (from Windows Mobile to Windows Phone) and Nokia (from Symbian to MeeGo) and RIM (from Blackberry OS to QNX). In fact, survival of a transition is relatively rare and never without significant pain and loss of value or share.

This is also understandable through the lens of disruption theory. As a product reached the point of being good enough, "breakthroughs" are harder to come by. Engineers and marketers struggle to push the product into increasingly rarefied strata of performance. The old architecture does not fit the new demands but it's crammed into them anyway. This last big push is then followed by a stall and ultimate demise. Meanwhile, an entrant gains lift in the rich atmosphere of new bases of competition with an architecture that's built specifically for it. The process then repeats.

And so the charts relate the same story of sustaining improvements followed by inevitable last gasps that Clayton Christensen first illustrated[5] in The Innovator's Dilemma. A book that came out just as the first mobile platforms cataloged in these charts began their ascent.

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Notes:

1. Versions of Symbian do not match easily to integer values. I used the versions as recorded by pdadb.net. The sequence is as follows: EPOC Release 3: "1", Release 4: "2", Release 5: "3", Symbian OS 6.0: "4", OS 7.0: "5",  OS 8.0: "6", OS 9.1: "7" (9.0 was deproductized), Symbian ^3: "8". Symbian ^4 has been cancelled. These original version numbers are noted on the chart.
2. The times recorded are for "general availability of product" which in the case of mobile OS's means the time when a device using that OS was released.
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   Symbian
   PalmOS
   Blackberry
   Jun-97
   Jun-96
   Jan-99
   Oct-99
   Mar-97
   Apr-00
   Mar-00
   Mar-98
   Mar-02
   Jun-01
   Mar-01
   Oct-03
   Oct-03
   Oct-02
   Nov-09
   Nov-04
   Sep-10
   Feb-06
   May-11
   Sep-10
3. End of life is defined as the last version generally available. In some cases (e.g. PalmOS 6) newer versions are built but they may not be released into a working complete product.
4. Windows Mobile is treated differently here than in the previous post. I chose to declare it EOL after version 6 and consider Windows Phone as a separate OS. This is because the name change is indicative of a break with the past. As before, I defer decisions about continuity to the developers and/or marketers who choose the naming conventions.
5. See slides 3 and 5 here

RIM shipped 10.6 million Blackberries and 200,000 PlayBooks in the last quarter. Management noted that their sell-through was significantly higher for Blackberry (13.7 million) but seems to be very weak for PlayBook as the prior quarter saw 500k units shipped. Additional PlayBook units this quarter probably mostly went into new channels in Asia and there were no additional sales into North America or Europe.

The figures for units are very poor. How poor depends on the frame of reference. Consider the shipment chart below:

In terms of the competition, 10.6 million units is less than half what Apple or Samsung sold in its prior quarter. It's also less than what HTC sold. RIM's volume rank will likely go to fifth place as a smartphone vendor.

In terms of its performance relative to its own history, the Blackberry volume dropped by 11% year-on-year and 18% sequentially. This is the second quarter that shipments shrank.

In terms of market share, we'll have to wait for the competitor data over the next six weeks but the market has been growing at an average of 77% for four quarters so any continuation of this trend would imply RIM's share dropping to single digits.

Finally, the biggest shock has been the decline in profitability. It seems that operating margin dropped from 21% to 13%. The company did incur some one-time charges for recent layoffs, but even without that charge, the margins would be around 16%. This is most alarming. The reason for such drops is that as volumes decrease fixed costs don't decrease as rapidly or at all. The company still needs to keep sales, administration and engineering staff around and they become a larger part of the operating expenses (vs. the component costs which vary with volume of goods sold).

This effect is well understood by financial analysts and the stock price shows it with a huge drop.

But stepping back to look at the picture above, there is a clear turning point in the company. You can see the elbow in the curve for volumes whose effect is felt so deeply. What's curious is why the pivot occurred when it did. We can point the finger to competition as the cause. But why was there no effect in the company's fortunes when the competition actually emerged. It's been years since the iPhone and even Android entered the market. Yet we see an impact on Nokia and RIM individually at apparently arbitrary points of time.

This is the lament of the analyst: you can clearly and accurately state what will happen but when remains a mystery. It's the elasticity between obvious causes and their effects that makes this an inexact science or not a science at all. In retrospect, you can say that Nokia's pivot was triggered by its public execution of Symbian, but that assumes that it was preventable--which we know is not the case. But what caused RIM's change of growth, exactly? Why did it happen this past spring? Why didn't the company volumes begin to decline as iPhone and Android boomed in 2009 or 2010? For quite some time RIM seemed immune to competitive pressure. We all were made fools as we called its imminent demise. Then, as Steve Jobs would say, boom!

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Footnote:

Piecing together RIM's performance is becoming more difficult each quarter. The data being presented is increasingly obfuscated by irrelevant detail while major information is omitted. This last management presentation was full of holes, namely:

• We have no idea of device pricing. Valiant efforts have to be made to piece together that aspect of the business. Matt Richman does a good job but it still requires some guesswork regarding PlayBook pricing to back out Blackberry pricing.
• Management detailed where Blackberries were selling-out but only detailed sell-in for the PlayBook. Obvious spin.
• They are cherry picking the data they present and each quarter it's a different story making pattern recognition impossible.

This leads to an erosion of trust. Observers are faced with the problem of increasingly guessing what is happening each quarter. For instance, regarding pricing I prefer to include service revenues in the analysis of device sales because device+service is what is being bought by the user and vendors which can offer services as part of the device get a justifiably higher value for the product--value that I think needs to be considered as advantageous. Nokia and Apple also account for services (though not apps) as part of device sales and it makes it more convenient to compare these businesses.

Given RIM's smokescreen, this quarter I decided to stop trying to guess Blackberry pricing and used Operating Income/Units sold as the average selling price.

 

In yesterday's post about the "biggest mobile loser" I covered the exodus of users from non-smart devices in the US and EU5. I also said that what happens in those regions tends to happen in other regions with a time shift. In some regions it happens quicker but in most it happens more slowly.

But can we be sure that there isn't vast non-smartphone growth in other regions? Well, no, we can't be sure. At least not without access to reliable data.

But what we can track is the overall non-smart phone market and compare it to the smartphone market. Here are the growth rates of the two sub-markets:

The difference is plain to see. We can also note that the non-smart market may be heading into a contraction--something noted by some analysts close to the market--but no real sign of that happening in smartphones.

Beside growth, we can also see actuals and the split of various vendors' volumes in the market.

It's also clear that the top line has not moved much in the last few years. Next, the shares of the vendors.

Finally, the before-and-after share pies.

We can see that the growth story, if there is one, is coming from low-end entrants. In late 2008 the main brands had 90% share. They now have about 60% (in a flat market.) The growth is all from "Other".

What seems to be happening is that buyers in mature markets are swapping (or upgrading) from non-smart to smart and adopting new smartphone brands. At the same time, new users in emerging markets are increasingly adopting new non-smartphone brands.

So the question for the incumbent vendors is extremely important: Facing them are low-end and smartphone entrants engaged in a pincer movement, with obvious success; can the old brands survive?

The answer, as always, depends on whether the competition is symmetric or not. Low end competitors are usually structured around low cost structures. High-end competitors are exploiting new markets and new business models. For an incumbent to survive and fight on both fronts they'd have to adopt both of these models for themselves, simultaneously and quickly.

We can see that Sony-Ericsson and Motorola (Google) have thrown in the towel on the low end. The question of dual-front strategy is mainly relevant only for Nokia, Samsung and LG. LG is on the ropes and may actually be ready to exit the market so that really means Nokia and Samsung. Nokia has signaled continuing interest in the non-smart market (citing "the next billion users"). Samsung also seems to be hanging in there. Can they do it?

I cannot stress how difficult this is or how rarely it has been achieved. The two approaches are if not opposites then at least orthogonal. It's like Mission Impossible. You can't be a low cost global vendor while investing in R&D for differentiated platform-based devices. These are shaping up to be businesses requiring completely different skill sets. Few have the ability to host these skills inside one company. I can think only of one example.

Yesterday comScore published survey results for EU5 (France, Germany, Italy, Spain, UK) on smartphone use and installed base. The headline is very similar to what would be written about the US: Android had phenomenal growth over the last twelve months. I also noted that the apparent growth of Google (16.2% share change) seemed to be matched by an apparent decline of Symbian (-16.1% share change.) However the reading of the data is not so simple.

In order to understand what has happened to usage, it's much more valuable to look at consumption and the actual number of users rather than change in share of a subset of the market. Consider the following charts:

The bar chart shows that three platforms gained users in the last year (ending July) and that there were negligible losses in users by others. Negligible except for non-smart phones. A remarkable 29 million users moved from non-smart phones to smartphones. Those switchers switched into Android (16 million), iPhones (6.3 million) and RIM (3.4 million). Symbian even gained about 330k users. Microsoft lost about 1 million but its platform has not been actively promoted in that time.

When seen as a pie chart, you can see how the usage shifted from non-smart to smart even more clearly. It does not appear that Android took share from Symbian at all. Android took share from non-smartphones. The table in the link from comScore leads one to conclude otherwise.

I took the same approach to look at the US data (also from comScore). It shows a similar pattern.

In the US, RIM was a net usage loser but its losses also paled to the losses of non-smart devices. In comparing with EU5 the pattern is very similar.

I then combined the EU5 and US data and provided a view into the combined markets (note scale change from previous two charts.)

This shows the change in platform phones more or less being from non-smart to Android and iPhones. The total population is 470 million people--not insignificant. The total number of non-smart devices abandoned is nearly 60 million in one year, which equals the total number of new smartphone users. That's 12% of most of the developed world switching in one year. If this keeps up, the "tipping point" when smartphones will outnumber non-smart phones in use in these large markets will be in another year.

In terms of sales rate, the tipping point has already happened. Sales of smartphones crossed over in the US and Europe several quarters ago (November 2010 in EU5) and the trend is accelerating. Furthermore, if patterns of mobile technology adoption repeat as they have for the last two decades, emerging markets will follow in two to three years.

This tipping point observation has been repeated on this site a number of times when reflecting on the data in the US. Now it's becoming clear that the same pattern has been underway in Europe as well.

The big picture from the survey data is just how vast the demand for smartphones is. Some platforms are benefiting more than others in terms of share of growth, but the biggest mobile loser is clearly the non-smart phone. Not only is it an unprofitable product for almost every vendor, it is also being increasingly shunned by buyers.

At the same time, at 450 million users we're still only looking at less than 10% of the market. As this pattern spreads globally the platform install bases will be measured in the billions of users.

After processing more than 1500 data points on the performance of thirteen technology companies, patterns are beginning to emerge. The steps so far:

• Visualizing P/E and Growth as time series centered on a point of crisis.
• Plotting P/E vs. Growth with an eye toward any clustering/correlations for the cohort.
• Detecting and measuring any change in the relationship between P/E and Growth before and after the point of crisis.

The final step is to plot the changes in the relationship between pre- and post-crisis for the set of companies normalized to the same starting point and then classifying them: 

The chart shows how the "average P/Es" changed after 9/30/2008 vs. how the companies performed during those periods. An evocative categorization is suggested for the four quadrants.

One way to read the data would be as a degree of effect of the crisis. For example, in the case of HP, its P/E dropped by about 6.5 while its average growth decreased by 41 basis points giving an average of 0.16 drop in P/E for every basis point reduction in growth. That would be a fairly modest impact. In the case of HTC, the impact would be even less. The effect on P/E was zero even though growth dropped by about 78 basis points. At the same time the impact on Microsoft was severe with the P/E dropping as much as for HP even though its growth only moderated by 5 basis points.

Therefore the "slope" (or angle in vector parlance) of each of the lines in the chart above may be interpreted as the severity of discount in value that the crisis invoked. Those values are shown the following chart:

A strong bar on the right half of the chart implies severe impact, a bar around the middle implies minimal impact and a bar in the left represents an inverse relationship where the market priced in opposition to performance[1]. What should be considered along with this chart is the quality of earnings and consistency of performance (which are shown in the posts linked above.)

Discussion

As noted in a previous article, there are really only six companies which had strong separation between pre- and post-crisis valuations: Apple, HP, RIM, HTC, Microsoft and Google. They are also the companies which had strong P/E drops (except for HTC). As a group they are also the companies with the best growth stories historically. This is perhaps the reason for the drop. Basically, because these were strong companies they "had the most to lose". The market "punished" them more severely than the weaker companies because the weak had already been discounted.

The other observation is that Apple and RIM are not treated particularly differently. The drops in P/E are at about 1 for every basis point drop in growth. This means that the the degree of value lost is about the same as a function of growth loss. Microsoft seems to have been the most affected. We can argue that it is perhaps weaker than the others strategically so this is reflected here, but I doubt it's weaker than RIM. Microsoft is also in contrast with Google which seems to have been given a lot of benefit of the doubt.

Nonetheless, this framework offers some hints on how technology companies have been treated after the crisis. There is no rightness or wrongness about this treatment but it may indicate potential for significant reaction in the opposite direction if and when macroeconomic conditions improve. These vectors are, in a way, proxies for volatility or "beta" in terms of correlation to the overall market. The greater the beta, the more amplification to market movement; the greater the slope value

As always, Apple is the canary in the coal mine as far as sentiment is concerned. What should be watched is the pricing reaction as Apple moves from a net reduction in growth to a net increase in growth. How will P/E react? The argument on this site so far has been that growth is exceptionally strong for Apple and it's not being reflected in the price. However, in this analysis we've stretched the time frame and did a longer retrospective. On this new time scale growth is not yet at the levels Apple enjoyed in the heady days of 2005/6. Perhaps this growth will return and when it does we'll get to see which way Apple's vector moves.

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Notes:

1. An inverse relationship with value can happen for various logical reasons, for example that a company has volatile performance which is depending on anomalous events.